Valuation and Analysis of Dual-Trigger Contingent Convertible Catastrophe Bonds

As an efficient method for reducing systemic risk, contingent convertible bonds (Cocos) have received widespread attention, especially in banking. Similarly, contingent convertible catastrophe bonds (CocoCATs) are effective in the insurance system to minimize catastrophic risks. In this study, we design and price a dual-trigger CocoCAT (DCocoCAT) for insurers. The trigger mechanism of the bond includes two conditions: the cumulative catastrophic losses and the insurance company’s share price. Compared with the single-trigger Coco, which uses only the cumulative catastrophic losses as the trigger condition, the DCocoCAT can comprehensively weigh the amount of catastrophic losses and the financial situation of the insurance company. Moreover, the bond can supplement the catastrophe repayment funds for insurance companies more appropriately and avoid unnecessary debt-to-equity conversions while in good financial situations. We derive the trigger probability and valuation formulae for DCocoCATs and perform a numerical analysis by using typhoon data from China. The results reveal that DCocoCATs have a lower probability of conversion into equity than do CocoCATs. Moreover, DCocoCAT prices are highly sensitive to the trigger threshold of share price and decrease as the volatility of the underlying stock increases. We calculate the optimal issue size of DCocoCATs in accordance with regulatory requirements and on the basis of the financial situation of the issuing insurance company